Originally published in Kiplinger’s Retirement Report
Are you looking for an additional income stream in retirement? Do you want to leave behind something for charity and cut your tax bill now and when you pass away? If the answer is yes, a charitable remainder trust might be right for you.
A CRT is an irrevocable “split-interest” trust that provides income to you and any designated beneficiaries for a specified number of years (up to 20) or for the rest of your life or a beneficiary’s, with the remaining assets donated to charity. Between 5% and 50% of the trust’s assets must be distributed at least annually, but 10% or more of the CRT’s initial value must eventually go to charity.
There are two types of CRTs. With a charitable remainder annuity trust, or CRAT, a set amount is distributed to you or beneficiaries that aren’t charities each year. Once you set up a CRAT, you can’t contribute more to it later. With a charitable remainder unitrust, or CRUT, distributions are based on a fixed percentage of the trust’s value, which is redetermined annually. You can also put more into a CRUT after it’s created. Both types of CRTs have tax advantages.
Estate tax savings. According to Jim Ferraro, vice president and trust counsel of Argent Trust Co., CRTs are first and foremost a “tool for reducing the estate tax for people who are charitably inclined.” That’s be-cause assets contributed to these trusts are generally not included in your estate when you die. If they’re not part of your estate, they won’t be subject to the federal estate tax. You may even be able to avoid the tax altogether if the total value of the estate is reduced below the estate tax exemption amount for the year of death. That amount, which was $11.7 million in 2021, rises to $12.06 million in 2022. The exemption is doubled for married couples if portability is elected on Form 706 after the death of the first-to-die spouse.
Deductions and deferrals. You can also claim an itemized charitable deduction on your income tax return for the year you set up a CRT. The deduction is for the projected amount that will go to charity. Because a charity’s future interest isn’t always clear when the CRT is created, a complicated formula is used to calculate it. The formula is based on your age or the age of any other beneficiaries, whether a CRAT or CRUT is used, and the rate of distribution, among other factors.
You can also defer payment of capital gains taxes if you place appreciated capital assets, such as stock or real estate, in a CRT. If you sell assets outside of the CRT, the tax is due when you file your income tax return for the year of sale. But if you transfer the asset to a CRT, the trust can sell it tax-free. However, as Ferraro notes, the “character of the income or gain is trapped within the CRT” by IRS regulations that dictate how distributions are taxed. Although there is the potential for some tax-free income, portions of the distribution also may be treated as ordinary income, capital gain or other income and taxed accordingly. For capital gains, though, the tax bill will be delayed and you may owe those taxes only when you file your income tax return for years that you receive a distribution.
A stretch IRA substitute. CRTs can also be used as an alternative to “stretch” IRAs, which were eliminated for most people in 2020. Under the old rules, non-spouse IRA beneficiaries could spread distributions from an inherited account over their own lifetime and leave the rest of the money to grow tax-free for de-cades. Now, all funds from an inherited IRA generally must be distributed to non-spouse beneficiaries within 0 years of the IRA owner’s death. To get around the new rules, you can name a RT as your IRA beneficiary and set up the trust to provide income for life to someone other that a spouse. Although the tax benefits are nice, Ferraro urges people not to “let the tax tail wag the dog.” If you’re not charitably inclined, don’t opt for a CRT. “Charitable remainder trusts are not for everyone.”
Jim Ferraro is a vice president and trust counsel in the Shreveport, La., office of Argent Trust Company. Ferraro is a 2003 graduate of the University of Missouri at Kansas City School of Law, past president of the family and the law section of the Kansas City Metropolitan Bar Association, and is a member of the Tax and Estate Planning Council of Shreveport.